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After concluding that a particular filing position can be recognized (i.e., has a more-likely-than-not chance of being sustained), ASC 740-10-30-7 requires that the amount of benefit recognized be measured using a methodology based on the concept of cumulative probability. Under this methodology, the amount of benefit recorded represents the largest amount of tax benefit that is greater than 50% likely to be realized upon settlement with a taxing authority that has full knowledge of all relevant information.
The analysis that needs to be performed and the level of documentation that needs to be created will vary based on the significance and complexity of the issue, as well as the degree of perceived uncertainty in the tax law. In some cases, this may require entities to develop a cumulative probability table. In other cases, this may not be necessary.

15.4.1 The cumulative probability approach

ASC 740 does not define “cumulative probability.” However, the term is included in the measurement examples provided in ASC 740-10-55-102 through ASC 740-10-55-107. When more than two outcomes may alternatively resolve an uncertain tax position (i.e., resolution may occur other than on an “all-or-nothing” basis), the measurement step requires that each potential outcome be assigned a probability to determine the greatest amount of tax benefit whose probability of being realized is greater than 50%.
The outcome that provides the greatest tax benefit should be assessed first. If that outcome’s individual probability is greater than 50%, the individual probabilities of the remaining outcomes need not be considered. The measurement step is concluded because the greatest amount of benefit was obtained from the most favorable outcome. Alternatively, if the individual probability of the greatest tax benefit is less than 50%, the next most beneficial outcome should be assessed. If that outcome’s individual probability, coupled with the individual probability of the greatest tax benefit, is greater than 50%, the second most beneficial outcome should be selected for measurement. If the cumulative probability of the second most beneficial outcome is not greater than 50%, the entity should continue the process until the probability of the selected outcome (added to the more beneficial outcomes previously assessed) is greater than 50% on a cumulative basis.
The concept of cumulative probability is best understood through an example. Assume that a tax return includes a position that results in an as-filed benefit of $100. It is more-likely-than-not that the position will be sustained based on its technical merits and thus meets the requirement for recognition.
Amount of the “as filed” tax benefit that can be sustained
Probability of each outcome
Cumulative probability
$100
40%
40%
$75
20%
60%
$50
15%
75%
$25
15%
90%
$0
10%
100%
100%

In this case, $75 is the amount of tax benefit that would be recognized in the financial statements because it represents the largest amount of benefit that is more than 50% likely to be sustained upon settlement, based on cumulative probability.
Although ASC 740-10-30-7 requires the consideration of a range of possible outcomes, as well as their individual and cumulative probabilities (when appropriate), it does not mandate the use of cumulative probability tables. Some tax positions that meet the requirement for recognition may have one expected outcome that is clearly more than 50% likely to be sustained if challenged by the relevant taxing authority. ASC 740-10-55-109 provides an example of this situation:

ASC 740-10-55-109

In applying the recognition criterion of this Subtopic for tax positions, an entity has determined that a tax position resulting in a benefit of $100 qualifies for recognition and should be measured. In a recent settlement with the taxing authority, the entity has agreed to the treatment for that position for current and future years. There are no recently issued relevant sources of tax law that would affect the entity’s assessment. The entity has not changed any assumptions or computations, and the current tax position is consistent with the position that was recently settled. In this case, the entity would have a very high confidence level about the amount that will be ultimately realized and little information about other possible outcomes. Management will not need to evaluate other possible outcomes because it can be confident of the largest amount of benefit that is greater than 50 percent likely of being realized upon settlement without that evaluation.

It is important to note that a virtually identical tax position could be measured differently by different preparers based solely on management’s appetite for risk and willingness to compromise. For example, an entity might determine that if it is challenged, it would continue to litigate the tax position to the court of last resort and the probability of sustaining the full amount of the benefit is greater than 50%. In this fact pattern, the entity would record the full amount of the benefit. However, another entity might believe that upon challenge, it would be willing to settle for 80% of the tax benefit. Assuming the expectation of settlement at this level is greater than 50%, that entity would record 80% of the benefit.

15.4.1.1 Individual probability and possible outcomes

Determining the individual probability of each possible outcome will require management to exercise judgment. Probabilities can be based on factors such as (1) the perceived weight of the tax law in the taxpayer’s favor, (2) the extent of precedent of the tax law being applied to the particular position or transaction, (3) expectations regarding how aggressively the taxing authority might pursue a particular position or, alternatively, its willingness to reach a negotiated compromise, and (4) the entity’s willingness to defend the position in tax court (as opposed to conceding to a negotiated compromise to avoid extended litigation). Comparable and resolved exposures that the entity or similar entities have experienced will often inform the development of measurement estimates and the assignment of individual probability. A history of negotiating and settling the same or similar tax positions would provide strong evidence in support of individual probabilities.
Furthermore, while all potential outcomes (e.g., litigation, negotiated compromise) should be considered to determine possible measurement outcomes and their individual probabilities, detection risk cannot be considered. That is, measurement must be performed under the assumption that the taxing authority has full knowledge of the uncertain tax position.

15.4.1.2 Consideration of past income tax audit experience

A taxpayer’s past audit results can be considered in measuring the most likely amount of tax benefit that can be recorded for an uncertain tax position. For measurement purposes, recent settlements can be considered a reliable indication of the expected tax benefit that will be sustained on an audit of the same or a similar tax position, as long as no new information has arisen to suggest that the previously negotiated outcome would no longer be acceptable (ASC 740-10-55-109). That said, a taxpayer’s history of settlement with a taxing authority on the same or similar tax positions is only one source from which expected outcomes may be derived.
A taxpayer’s lack of or limited audit history should not impact its ability to estimate the expected outcome for measurement of a recognized tax benefit. As discussed previously, when determining expected outcomes, a taxpayer must assume that the taxing authority has full knowledge of the uncertainty. When a taxpayer has limited or no audit experience, other taxpayers’ experience with negotiating and settling the same or similar positions can be used as a source of expected outcomes. Relevant law (e.g., statute, regulations, rulings, case laws) that provides an indication as to the expected amount of tax benefit that may be sustained can also be used to inform the estimate of expected outcomes.

15.4.1.3 Highly certain tax positions

The tax treatment of certain tax positions is based on clear and unambiguous tax law. For these positions, the amount of benefit that is expected to be sustained is near certain. The measurement of highly certain tax positions often represents 100% of the benefit expected to be or actually claimed in the tax return. The following reference demonstrates the measurement of a highly certain tax position.

ASC 740-10-55-100

An entity has taken a tax position that it believes is based on clear and unambiguous tax law for the payment of salaries and benefits to employees. The class of salaries being evaluated in this tax position is not subject to any limitations on deductibility (for example, executive salaries are not included), and none of the expenditures are required to be capitalized (for example, the expenditures do not pertain to the production of inventories); all amounts accrued at year-end were paid within the statutorily required time frame subsequent to the reporting date. Management concludes that the salaries are fully deductible.

ASC 740-10-55-101

All tax positions are subject to the requirements of this Subtopic. However, because the deduction is based on clear and unambiguous tax law, management has a high confidence level in the technical merits of this position. Accordingly, the tax position clearly meets the recognition criterion and should be evaluated for measurement. In determining the amount to measure, management is highly confident that the full amount of the deduction will be allowed and it is clear that it is greater than 50 percent likely that the full amount of the tax position will be ultimately realized. Accordingly, the entity would recognize the full amount of the tax position in the financial statements.

15.4.1.4 Binary tax positions

A taxing authority may not always be willing (or in certain cases legally permitted) to accept a compromise on a position. Additionally, there may be positions taken by an entity that are so significant (e.g., status of the entity) that the entity cannot negotiate with the taxing authority. This subset of uncertain tax positions are considered binary. This means there are two possible outcomes:
1. The position is sustained and the entire as-filed tax return amount (i.e., 100% of the benefit) will be accepted.
2. The position is lost upon challenge and none of the as-filed tax return amount (i.e., zero benefit) will be accepted.
When a binary tax position qualifies for recognition, the measurement should be based on the largest amount of tax benefit that is more likely than not to be realized upon settlement. This would generally cause 100% of the expected benefit (i.e., the as-filed amount) to be recorded.

15.4.2 Interplay of measurement and recognition of tax positions

Generally, the individual and cumulative probabilities that are considered relevant to the measurement step would not have a direct impact on the recognition step. Once a tax position has satisfied the more-likely-than-not requirement for recognition, the position should be evaluated to determine the measurement of the largest amount of tax benefit that can be recorded in the financial statements. However, if only an insignificant amount of the tax benefit can be realized (i.e., the uncertain tax position liability is large in comparison to the amount of benefit recognized) the entity may want to reevaluate the more-likely-than-not conclusion reached in the recognition step.

15.4.3 The implications of “should” level tax opinions

The recognition and measurement of a tax position are two separate steps in the ASC 740 accounting model. A tax opinion issued by outside counsel or tax service provider can constitute external evidence supporting management’s assertions in relation to the recognition of a tax position. A tax opinion that concludes that a tax position “should” be sustained may indicate that the recognition threshold has been met. It may not, however, be sufficient to justify recording 100% of the expected tax benefit, especially if the opinion addresses the sustainability of the position without identifying the amount that can be sustained. For example, if an entity knows (or has reason to believe) that the relevant taxing authority expects some concession and the entity does not intend to litigate, the largest amount of benefit that has a cumulative probability greater than 50% may be less than 100%, notwithstanding the existence of a should opinion.

15.4.4 Measurement and transfer pricing

Transfer pricing generally refers to the method of determining the price of goods, intangibles, and services in transactions between commonly controlled companies. The pricing calculation is often multifaceted, taking into account economics, finance, industry practice, and functional analyses. As a result, one company’s transfer pricing position often sits at a particular point along a wide continuum of possible pricing outcomes. Absent a reasonable number of comparable and resolved exposures that the entity or similar entities have experienced, there might not be sufficient information to develop a probability assessment of every possible outcome. Despite this, the entity must develop and support a conclusion as to which possible outcome represents the one that provides for the greatest benefit that has a greater than 50% cumulative probability of being sustained.
The assignment of probabilities to a particular outcome is not an exact science. This exercise depends heavily on the facts and circumstances that are specific to the particular transaction in question, management’s experience and knowledge of the tax authority’s position on particular transactions, and the experience and knowledge of industry peers with respect to settlements and strategies. Advanced pricing agreements with the relevant tax authorities can be helpful in determining how to measure any uncertain tax positions related to transfer pricing.
An uncertain tax position taken in one jurisdiction related to transfer pricing may give rise to a corresponding tax position reducing taxable income in another jurisdiction where an affiliate resides. Any corresponding tax payable (or receivable) from the potentially offsetting transactions should be recorded on a gross basis on the balance sheet. As mentioned in TX 15.3.1.5, entities measuring the amount of an uncertain tax position should evaluate any potentially offsetting transactions separately.
Contemporaneous documentation typically helps determine whether an entity appears to have met the standards of reasonableness with respect to transfer pricing penalties. It may not, however, determine the likelihood that a position will be sustained, whether a particular position has a greater than 50% cumulative probability of being sustained, or whether there are particular alternative outcomes that might be asserted by the respective taxing authorities. Accordingly, entities may need to consider alternative transfer pricing methods or profit-level indicators in their analysis of alternative settlement positions. The best method for transfer pricing documentation is not necessarily the only method that should be considered. The best method analysis contained in transfer pricing documentation may describe only why an entity did not choose other methods (and should be protected from penalty exposure). Entities may need to review other methods and their respective results more closely when considering ASC 740.

15.4.5 Tax rates and uncertain tax positions

The income tax rate to be applied to an uncertain tax position may be dependent on the nature of the tax uncertainty as well as the period to which the uncertainty relates. Liabilities should generally be recorded at the enacted income tax rate associated with the period of the uncertainty. For example, assume a company records a liability for an uncertain tax position that meets the recognition threshold related to a position taken in its Year 1 tax return. In Year 2 there is a change in tax rate. The company should maintain its liability at the enacted tax rate for Year 1 as this is the rate the company would be charged if the company’s Year 1 tax position was not sustained. However, if the liability for an uncertain tax position taken in Year 1 is expected to reverse in a future year by affecting income taxes payable (e.g., through utilization of an NOL generated in Year 1), the uncertain tax position liability should be measured using the Year 2 tax rate.
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